Securities lending in the UAE: the race is on

In early August last year, the
National Bank of Abu Dhabi (NBAD)
became the first institution in the
UAE to be handed a licence to
carry out securities lending and
borrowing activities within the country’s
capital markets. The Securities and
Commodities Authority (SCA), the
regulator that granted the approval,
stated at the time that the move would
offer several benefits, including helping
to bolster the local securities industry,
increasing the market’s depth and
encouraging more investment in the
capital markets from both local and
foreign institutions.

Under the system, clients temporarily
transfer ownership of their securities
to a borrower that can then use the
shares in its market making activities.
Collateral is posted to the lender, either
in the form of a cash guarantee or a bank
guarantee or by using other securities.
The lender in turn has the chance to earn
revenues from the use of their shares.
The borrower is obliged to return the
securities to the owner at an agreed date
in the future or on demand, depending
on what is agreed.

The lending of securities is a common
activity in many parts of the world,
including Europe, Asia and the Americas,
but it is still rare in the Middle East region.
It has not happened quickly in the UAE
and although it is nearly a year since the
first licence was granted, the process is
still not quite complete.

The SCA board first set out its
conditions and requirements for
potential licence holders in August
2012, with decision no. 47 “concerning
the regulations as to lending and
borrowing securities”. The country’s
main stock market, the Dubai Financial
Market (DFM), approved the practice
in January 2014 and the Abu Dhabi
Securities Market (ADX) followed a few
months later in May. Maryam Fekri, chief
operating officer of the DFM, described
the move as “an important development
for the market… diversifying the range of
products to be offered and increasing
the UAE’s attractiveness for investments.”

However, it is still a work in progress.
NBAD has still not yet launched the
product in the market and it is keen to
keep expectations in check about what
sort of an impact it might have, in the
short term at least.

“Eventually, this will be a product which
increases the liquidity and the depth of
the market and will unlock additional
value in the long equity positions of
many of our institutional investors, but we
are just getting started,” says Jonathan
Titone, executive director and head
of product development at the bank.
“There have been a few setbacks in our
journey, and it has taken a bit longer than
we had hoped to start the lending and
borrowing activity, but we are working
very closely with the markets to launch
this and they are nearly ready.”

Restrictions remain

One critical factor that he points out is
likely to limit the take-up of the product
in the months following any launch is the
ongoing restrictions on short-selling of
stocks in the UAE.

“Market makers are currently the only
investors to have any demand to borrow
as they are the only investors that are
allowed to short sell in the market,” he says. “Other investors face preverification
requirements by the stock
exchanges whereby securities must be
available in their account prior to trade
execution. If the shares are not available,
the trade cannot be executed. So
other than short selling through market
making, there is little demand or purpose
to borrow shares. Because of this, we
must manage expectations in terms of
the limited demand and initial financial
returns.”

NBAD says it has received positive
interest from potential clients who are
keen to explore ways to turn their longterm
holdings into another source of
revenue. In the longer term, the process
could prove to be a handy way for some
investors to hedge their positions. Other
market participants say that it could also
play a useful role in paving the way for
other innovations in the future and to
support other products.

“The implementation of securities
lending and borrowing is an important
development for the market because
it diversifies the range of products that
are up for offer,” says Mihir Kapadia, CEO
and founder of Sun Global Investments,
a wealth management company with
offices in Dubai, London and Mumbai.
“It is a key piece of market infrastructure
for the development of other market
products such as exchange traded
funds.”

However, there are some reasons to
doubt whether the product will prove
quite as popular as it has in some other,
more mature markets, given the nature
of the region’s shareholders. In particular,
some observers say there are many
firms in the UAE that have no interest
in doing anything with
their shares other than
holding on to them. It
is likely to take some
time to educate such
investors and persuade
them of the benefits of
lending their shares.

“You have some
clients that have large
positions in firms and
they may be interested,
but for the most part the
investor base that own
the more established
publicly-listed institutions don’t want to
do anything with those shares outside of
just hold them for dividend payments,”
says one Dubai-based executive.

Instead, if the authorities want to
improve liquidity in the market, they
may be better off focusing on opening
up the market to international investors.
That has been gradually happening,
encouraged by the MSCI upgrade in
May 2014, when the UAE was included
in the firm’s emerging markets index.

In June last year, the UAE federal
government decided to lift its ban on
non-UAE investors owning shares in
local telecoms giant Etisalat. The change
went ahead in mid-September, with a
20% ceiling on foreign ownership. Rival
telecoms outfit Emirates Integrated
Telecommunications Company (Du) has
been touted to follow suit by investment
bank Arqaam Capital.

Predicted demand

The fact that no other licences have yet
been awarded for securities lending
and borrowing suggests that other
institutions are at best cautious about the
potential for this product. Nonetheless,
Titone appears confident that there will
be plenty of demand from clients wanting
to lend their shares and that, in time,
others will want to follow NBAD into the
market. That optimism stems in part from
the fact that the regulator is expected to
loosen the restrictions on short-selling in
the future. Whether that transpires is still
a moot point, but there is optimism in the
industry.

“There is strong interest on the
client side to lend their shares,” says
Titone. “We expect
other market makers
to enter the market
soon, and the regulator
and markets are also
planning to introduce
short selling for
investors, other than
market makers, in the
near term. Once this is
possible, demand will
increase exponentially,
and we expect even
more competition to
enter the market. We
believe there will be significant demand
in the medium term."

Furthermore, says Titone, there are
large institutional investors holding
large blocks of very attractive securities.
“These investors have no intention to
sell the positions any time in the near
future, and these positions can be used
to generate additional yield.”

The idea of securities lending and
borrowing should receive a further
boost early next year from another
development in the region. In early May
this year, the Capital Market Authority
(CMA) in Saudi Arabia announced that it
will soon permit the practice for trades on
the Saudi Stock Exchange (Tadawul). It is
due to issue the necessary regulations
during the first half of 2017. What
happens in the kingdom, the Middle
East’s largest economy, invariably affects
other Gulf states.

Securities lending has been a long
time to arrive in these countries, but once
the product is available in the market
it ought to find a loyal and growing
following. The race is on.

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